Bankruptcy, Reorganization

and Liquidation

Totok Wijonarko, Ivan Clouet, Ratna Kartika

Causes of Business Failure
❏ Economics factors : industry weaknesses, poor location…
❏ Financials factors : too much debt, insufficient capital…

Size of firm which are more prone to business failure

➢ More frequent for smaller firms

➢ Biggest firms : Federal government’s bailouts

 ● Is this a temporary cash flow problem (technical insolvency), or
is it a permanent problem caused by asset values having fallen
Key issues
below debt obligations (insolvency in bankruptcy)?
must
managers face ● Who should bear the losses if this is a permanent problem?

in the financial
● Would the firm be more valuable if it continued to operate or if it
distress were liquidated and sold off in pieces?
process
● Should the firm file for bankruptcy, or should it try to use
informal procedures?

● Who should control the firm during liquidation or

reorganization?
 Informal Remedies
Available
Informal Reorganization Informal Liquidation
Used when : Temporary financial difficulties Used when : The firm is worth more by selling it
off in pieces
“Workouts” voluntary plans
Assignment (informal procedure for liquidation)
Restructuring : Current debt are revised to
facilitate the firm’s ability to pay Title to the debtor’s assets is transferred to a
third party, called assignee or trustee, and then
⇒ Extension : creditors postpone the dates of the assets are sold off.
required interest or principal payments, or both.

⇒ Composition : creditors voluntarily reduce

their claims on the debtor or the interest rate on
their claims.
Federal Bankruptcy Law v. Indonesian
Bankruptcy Law
1. Voluntary and Involuntary 1. Voluntary and Involuntary
2. Temporary - gain more time without asset 2. PKPU
seizure
3. Bankrupt - stop operating
4. Trustee to take over the company if the
management incompetent
Reorganizations in Bankruptcy

The Common Pool Problem The Holdout Problem

Automatic Stay - creditor can only foreclose their Cramdown - lump creditors into classes . ⅔ of
individual claim debt and 1 ½ claimants

Fraudulent Conveyance - unjustified transfer of

property by a firm in financial distress

FAIRNESS and FEASIBILITY

Prepackaged Bankruptcies

INFORMAL WORKOUT
ADVANTAGES:

Reduction of holdout problem

Preserving creditor’s claims

Tax
FORMAL WORKOUT
Liquidation

● Supervisory Judge to supervise, Curator to liquidate assets

● Preferred/Secured creditors have priority claim
● Concurrent Creditors will get the remaining assets in pro rata
portion
 Bankruptcy Prediction: Altman Z-Score Model

The Altman Z Score model, defined as a financial model to predict the

likelihood of bankruptcy in a company, was created by Edward I.
Altman. He was a professor at the Leonard N. Stern School of
Business of New York University

The purpose of the Z Score Model is to measure a company’s financial

health and to predict the probability that a company will collapse within
2 years

The model is based on five financial ratios that can calculate from data
found on a company's annual report: profitability, leverage, liquidity,
solvency, and activity
Altman Z Score Formula:

Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

A = working capital / total assets

B = retained earnings / total assets

C = earnings before interest and tax / total assets

D = market value of equity / total liabilities

E = sales / total assets

Altman Z Score Model Explanation

In general analysis, the lower the Z-Score, the higher risk of bankruptcy a
company has, and vice visa. The following table shows Z-Score and interpretation
for public manufacturing companies:

Z-score Interpretation
Above 2.99 Bankruptcy is not likely (safe zone)
1.81 to 2.99 Bankruptcy can not be predicted (grey zone)
Below 1.81 Bankruptcy is likely (distress zone)
Altman Z Score Model Explanation

Z-Score and interpretation for Z-Score and interpretation for

private manufacturing companies: private general companies:

Z-score Interpretation Z-score Interpretation

Above 2.9 Bankruptcy is not likely (safe zone) Above 2.60 Bankruptcy is not likely (safe zone)

1.23 to 2.9 Bankruptcy can not be predicted 1.10 to 2.60 Bankruptcy can not be predicted
(grey zone) (grey zone)

Below 1.23 Bankruptcy is likely (distress zone) Below 1.10 Bankruptcy is likely (distress zone)
Applying Z-score Models:
A Case Study of Some US Carriers

Conducted by: Chris C. Hsu, Ph.D., Director, CUNY Aviation Institute

York College, City University of New York, U.S.A

Background
Study was conducted over two U.S. publicly traded airline companies namely
American Airlines and Southwest Airlines

The financial data were extracted from the two companies’ 10K reports of 2009
and 2010

Both companies were affected by global financial crisis 2008 and started to catch
up as the economy recovered in 2010
Empirical
Application
Result & Discussion
The Z-scores of American Airlines were 0.6348 and 0.9005 in 2009 and 2010,
respectively, both figures were far lower than the threshold of 1.81 and fall into the
insolvency area

While, Z-score of Southwest Airlines were 1.9570 and 2.2411 in 2009 and 2010,
respectively, which are higher than the insolvency threshold of 1.81 (were located
in the grey zone)

It turned out then, American Airlines claimed bankruptcy on November 29, 2011
Conclusion
The study provides an empirical demonstration of how to include the Z-score
bankruptcy prediction model in aviation finance education

Unlike many bankruptcy prediction models which utilize sophisticated

mathematical methodologies, the Z-score model is a simple equation comprised of
five ratios with data that can be easily found in a company’s 10K reports